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Before Facebook filed
papers for an initial public offering, it was already trading in
secondary markets -- where insiders at hot tech start-ups can
sell their shares to investors hungry to get in -- such as
SharesPost and SecondMarket. In fact, prior to its filing, that
secondary market was valuing the social network at around $75
billion.

Most of the startups out there will never see that kind of
valuation on these secondary markets. And only a slightly higher
percentage of the total will even trade there. But like anything
that seems too good to be true -- that is, getting your hands on
shares of Facebook before it goes public -- these secondary
markets have their flaws. After all, anyone buying shares through
them won't see the kind of detailed financial reporting that the
Securities and Exchange Commission demands of public companies.

What's more, the ability for the SEC to police companies that
aren't public is also limited. That failing came to light
recently, as the SEC disclosed that some of the brokers that buy
and sell shares on these secondary markets allegedly hid extra
commissions they charged investors who wanted a piece of Facebook
Inc., Twitter Inc. and other social-media companies.

In this case, the SEC charged Frank Mazzola of Felix Investments
and Facie Libre Management Associates of earning secret
commissions on the sale of Facebook shares and stakes in the
funds, in addition to the 5 percent commissions disclosed to
investors, according to a report in The Wall Street
Journal.

Mazzola and two other Felix employees must pay a total of
$330,000 for allegedly breaching the rules on how investments can
be sold in their promotion of the Facebook funds. Finra alleges
that Felix pitched its secondary-market funds to at least 1,000
people through a mass email.

As far as startups go, the SEC crackdown on these abuses doesn't
mean much. That's because there are probably fewer than five
startups that already have enough buzz to create a feeding frenzy
for investors before their IPO.

For most startups, these secondary markets have no value as a
source of capital.

A better solution would be to rebuild public confidence in the
IPO market by enforcing standards for companies that list on the
exchange. When money losing companies go public at exorbitant
valuations and then crash six months later, the experience sours
investors.

But if the SEC required companies to be profitable before going
public and to sell shares at a reasonable valuation, then the
prices might rise in the after-market and create opportunities
for individuals to profit from investing in them.

And this could create a virtuous cycle that would revive the
market for venture financing of startups that has been broken
since 2000.

How do you think the SEC's crackdown on secondary
markets will affect startups? Let us know in the
comments section.